NICOR CORPORATION v. ILLINOIS DEPARTMENT OF REVENUE (2008)

ORDER

Plaintiff-appellee Nicor Corporation, an Illinois Corporation (Nicor), brought suit against defendants-appellants The Illinois Department of Revenue, Kenneth Zehnder, as its Director, and Judith Baar Topinka, as Treasurer of the State of Illinois (collectively, Department) to recover monies it paid under protest following an audit during which the Department concluded that Nicor had misrepresented a gain it received as “nonbusiness income” not allocable to the State of Illinois. The trial court granted Nicor's motion for summary judgment finding that the gain was nonbusiness income, and directed the disbursement of the funds back to Nicor. The Department appeals, contending that the trial court erred in granting summary judgment because a question of fact remains as to whether Nicor's gain qualified as “business income” (apportionable to Illinois) or “nonbusiness income.” The Department asks that we reverse the trial court's decision and, pursuant to stipulations the parties made at the outset of the litigation, remand for further proceedings including the opening of records to allow additional evidence as to the nature of the sale in question. For the following reasons, we affirm.

BACKGROUND

The parties agree to the relevant facts presented in the record.

Prior to 1993, Nicor was involved in the distribution, storage, exploration, production and containerized shipping of natural gas. Nicor owned all the stock of Nicor Oil and Gas Corporation (NOGC); NOGC owned all the stock of Nicor Exploration and Production Company (NEPC); and NEPC owned all the stock of five other subsidiaries engaged in natural gas exploration and production, including Nicor Exploration Company, Nicor Production Company, Nicor Supply, Inc., Reliance Arkoma Company and RPC Pipeline Corporation.¹ As the parent company of these affiliates, Nicor filed annual consolidated federal income tax returns as well as combined Illinois corporate income and replacement tax returns.

In 1993, NOGC sold all its stock in NEPC and, thus, its five subsidiaries, to Scana Petroleum Resources, Inc. (Scana). NOGC and Scana agreed to treat the sale as a deemed asset sale under section 338(h)(10) of the Internal Revenue Code of 1986 (Code) (26 U.S.C. § 338(h)(10) (1992)). Under this section, NOGC (the seller) agreed to sell the stock of the subsidiary NEPC and the five other companies (the target) to Scana (the purchaser) and to treat the transaction as a sale of assets by the target to the purchaser, rather than as a sale of stock. As a consequence of this section 338(h)(10) election, NEPC was treated as two unrelated entities; the “old” target and the “new” target. Via the section 338(h)(10) election, the old target was deemed to have sold its assets to the new target (purchased by Scana), distributed the sale proceeds to its shareholder (NOGC), and liquidated; NEPC and its five subsidiaries no longer existed. Meanwhile, the new target was deemed to have purchased all of the assets of the old target and to have become a separate entity now owned by Scana and no longer affiliated with NOGC or Nicor. Accordingly, the parties treated the sale as an asset sale by “old” NEPC to “new” NEPC, and the consideration for the sale was received by “old” NEPC and distributed to NOGC as the sole shareholder in complete liquidation of NEPC. As a result, Nicor ceased all its business related to the exploration and production of natural gas, retaining only its business related to distribution, storage, and shipping.

NEPC and the five subsidiaries sold for $68,969,176. Nicor reported this on its federal income tax return. In reporting the sale on its Illinois combined income tax return for 1993, Nicor listed it as “nonbusiness” income and, thus, did not allocate any of the amount to Illinois.

The Department conducted an audit of Nicor and determined that the gain on the sale was “business” income, not “nonbusiness” income as Nicor reported, and, thus, should have been apportioned to Illinois pursuant to its corporate business tax laws. The Department issued a notice of deficiency to Nicor, assessing additional taxes in the amount of $5,896,440 ($4,353,268 plus $1,543,172 in interest) due to the sale. Nicor timely paid the assessment, but did so under protest. It then filed a complaint at law against the Department pursuant to the Illinois State Officers and Employees Money Disposition Act (Protest Monies Act) (30 ILCS 230/l–230/2a. 1 (West 1998)).

During the litigation, the parties entered into certain stipulations, which included that: the controlling issue was whether the gain reported by Nicor qualified as nonbusiness income under American States Ins. Co. v. Hamer, 352 Ill.App.3d 521 (2004)² ; if the gain was nonbusiness income as a matter of law, none of it was allocable to Illinois; and, if the gain was conversely business income (and not nonbusiness income), the record on the matter should be reopened to introduce facts on the liquidating transaction's effect.

Nicor moved for summary judgment, arguing that American States recognized that Illinois accepts the consequences of a section 338(h)(10) election as a matter of law and that the business liquidation exception to the business income test applied, rendering the gain nonbusiness income. The Department argued that American States had been wrongly decided or, alternatively, that Nicor failed to meet all the elements of the business liquidation exception to qualify the gain as nonbusiness income.

The trial court agreed with Nicor, rejecting the Department's argument that American States had been wrongly decided and instead finding that case to be dispositive of the instant matter. Following American States, the court declared that the sale of NEPC, by the fact that it was conducted via a section 338(h)(10) election, automatically constituted a complete liquidation, the cessation of NEPC's business and the distribution of the proceeds to NEPC's shareholder as a matter of law, thereby leaving no issues of material fact that the gain qualified as nonbusiness income. Therefore, and in accord with the parties' earlier stipulations, the court concluded that none of the gain should be allocated to Illinois. The court entered summary judgment in favor of Nicor and ordered the return of all monies remaining in the protest fund following the issuance of the notice of deficiency, plus interest, back to Nicor; the court also ordered a stay pending the instant appeal.

ANALYSIS

As noted, the Department appeals from the trial court's grant of summary judgment in favor of Nicor. Summary judgment is proper when the pleadings, affidavits, depositions and admissions of record, construed strictly against the moving party, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law. See Morris v. Margulis, 197 Ill.2d 28, 35 (2001); accord Purtill v. Hess, 111 Ill.2d 229, 240–44 (1986); Zakoff v. Chicago Transit Authority, 336 Ill.App.3d 415, 420 (2002). While this relief has been called a “drastic measure,” it is an appropriate tool to employ in the expeditious disposition of a lawsuit in which “ ‘the right of the moving party is clear and free from doubt.’ “ Morris, 197 Ill.2d at 35, quoting Purtill, 111 Ill.2d at 240. Appellate review of a trial court's grant of summary judgment is de novo (see Rich v. Principal Life Insurance Co., 226 Ill.2d 359, 370 (2007); accord Outboard Marine Corp. v. Liberty Mutual Insurance Co., 154 Ill.2d 90, 102 (1992); Zakoff, 336 Ill.App.3d at 420), and reversal will occur only if we find that a genuine issue of material fact exists (see Addison v. Whittenberg, 124 Ill.2d 287, 294 (1988)).

When a corporate taxpayer, such as Nicor here, conducts business in several jurisdictions, the Illinois Income Tax Act (Act) (35 ILCS 5/101 et seq. (West 2000)) establishes methods by which its income will be divided among Illinois and these other jurisdictions; the method to be used depends on whether that income is “business income” or “nonbusiness income.” Business income is defined as “income arising from transactions and activity in the regular course of the taxpayer's trade or business,” and is subject to apportionment in Illinois. 35 ILCS 5/1501(a)(l) (West 2000). Nonbusiness income is defined as any income not deemed business income, and it is not allocable to Illinois. See 35 ILCS 5/1501(a)(13) (West 2000).

To determine whether a gain realized from the sale of an asset is business or nonbusiness income, the Department and Nicor here agree that the “functional test” is to be employed, which states that the gain is considered business income if the asset sold was used by the taxpayer in its regular trade or business operations, and focuses on whether the asset sold was integral to the taxpayer's regular business operations. See American States, 352 Ill.App.3d at 526.

There is no dispute that the sale of the asset in question, namely NEPC and the five subsidiaries, by NOGC to Scana was a sale conducted via a valid section 338(h)(10) election. In fact, the Department has conceded this not only in its brief on appeal, but also before this Court during oral argument held in this matter.

Section 338 of the Code states, in relevant part:

“ § 338. Certain stock purchases treated as asset acquisitions

(a) General rule.—

For purposes of this subtitle, if a purchasing corporation makes an election under this section * * *, then, in the case of a qualified stock purchase, the target corporation—

(1) shall be treated as having sold all of its assets at the close of the acquisition date at fair market value in a single transaction, and

(2) shall be treated as a new corporation which purchased all of the assets referred to in paragraph (1) as of the beginning of the day after the acquisition date.

* * *

(h) Definitions and special rules.—For purposes of this section—

* * *

(10) Elective recognition of gain or loss by target corporation, together with nonrecognition of gain or loss on stock sold by selling consolidated group.—

(A) In general.—Under regulations prescribed by the Secretary, an election may be made under which if—

(i) the target corporation was, before the transaction, a member of the selling consolidated group, and

(ii) the target corporation recognizes gain or loss with respect to the transaction as if it sold all of its assets in a single transaction,

then the target corporation shall be treated as a member of the selling consolidated group with respect to such sale, and (to the extent provided in regulations) no gain or loss will be recognized on stock sold or exchanged in the transaction by members of the selling consolidated group.

(B) Selling consolidated group.—For purposes of subparagraph (A), the term ‘selling consolidated group’ means any group of corporations which (for the taxable period which includes the transaction)—

(i) includes the target corporation, and

(ii) files a consolidated return.” 26 U.S.C. § 338 (West 1992).

According to the Department's concession that a valid section 338(h)(10) election was made by NOGC and Scana at the time of NEPC's sale, the Department also concedes, pursuant to section 338(a) and its subsections (1) and (2), that NEPC “sold all of its assets” and became, essentially, two corporations—the “old” liquidating NEPC which became nonexistent after the sale, and the “new” NEPC which became an entity unrelated to NOGC because it had now been purchased by Scana. Accordingly, NEPC did not continue its business; it was, for all intents and purposes, completely liquidated and ceased all business.³

This was indeed the result as the parties to the sale, as well as the parties to this appeal, agree that the section 338(h)(10) election was valid. Under this section, NEPC (the target) was a member of the selling consolidated group which included NOGC and Nicor before the sale; with the sale, NEPC became two entities, with old NEPC recognizing a gain or loss with respect to the transaction as if it sold all of its assets in a single transaction. See 26 U.S .C. § 338(h)(10)(A) (West 1992). When this occurs, as conceded here, section 338(h)(10) mandates as a matter of law that the target “shall be treated as a member of the selling consolidated group,” and “no gain or loss will be recognized on stock sold or exchanged in the transaction by members of the selling consolidated group.” 26 U.S.C. § 338(h)(10) (West 1992). Here, this requires that NEPC is treated as the member of the selling consolidated group comprised of NOGC and Nicor which recognized the gain or loss related to the sale, while Nicor, as a member of the selling consolidated group who filed the consolidated income tax return, could not have recognized either a gain or loss on the sale of NEPC stock. 26 U.S.C. § 338(h)(10), (B) (West 1992). The trial court's holding of summary judgment in favor of Nicor was proper, since, unable to recognize NEPC's sale as either a gain or loss pursuant to the section 338(h)(10) election, Nicor could only report it on its Illinois corporate tax return as nonbusiness income.

As did the trial court below, we find American States, and its holding that the sale of an asset via a section 338(h)(10) election results as a matter of law in nonbusiness income, to be directly on point. There, a parent corporation and its minority shareholders sold all the stock in a subsidiary insurance company to a third party in an agreed section 338(h)(10) sale. Accordingly, the target-subsidiary was deemed to have sold all its assets and ceased operations under that statute, and the proceeds from the sale were deemed distributed to the target's shareholders as the parent corporation recognized the gain on its income tax returns. Because, then, it could not be argued that the subsidiary continued business, the American States court found that “the section 338(h)(10) transaction must be treated legally as a complete liquidation and cessation of business,” resulting in nonbusiness income for the parent corporation as a matter of law. American States, 352 Ill.App.3d at 532.

The situation here is the same. Once NOGC and Scana agreed to a section 338(h)(10) election for the sale of NEPC, which the Department concedes was valid, NEPC was deemed under that section to have sold all its assets and ceased operations. And, when Nicor reported the gain in its income tax returns, it became clear that the proceeds from NEPC's sale had been distributed to the shareholders. Pursuant to section 338(h)(10), NEPC's sale must be treated as a complete liquidation and cessation of business, resulting in nonbusiness income for Nicor as a matter of law.⁴

CONCLUSION

Accordingly, for all the foregoing reasons, we affirm the judgment of the trial court.⁵

Affirmed.

FOOTNOTES

1.  We note for the record, as the parties have, that while Nicor was domiciled in Illinois, NOGP, NEPC and the five subsidiaries were all domiciled in Colorado and did not own any property in Illinois.

2.  Nicor filed a seven count complaint. Count I sought a statutory injunction, Count III alleged that the gain was not reportable to Illinois. Count IV alleged that apportionment would violate Nicor's due process rights. Counts V and VI alleged that Nicor was entitled to certain tax credits. Finally, count VII alleged that the Department had overassessed the interest it had charged in the notice of deficiency. During the litigation, the Department conceded Counts V and VI and, accordingly, the court ordered the release of $195,102 from the protest fund to Nicor.

3.  In fact, as noted earlier, the record shows that, with the section 338(h)(10) sale of NEPC, Nicor and its affiliates ended all its business related to the exploration and production of natural gas, and retained only its business related to distribution, storage, and shipping.

4.  Had the Department not conceded that NEPC was sold by NOGC to Scana via a valid section 338(h)(10) sale, then the arguments it made in its brief on appeal urging a focus on what Nicor, as the taxpayer, did with the proceeds of the sale would have had merit. However, with its concession, the Department's hands are tied, as the law is clear that a valid section 338(h)(10) election in the sale of an asset results in a deemed sale of assets and the complete liquidation and cessation of business concluding in, as a matter of law, nonbusiness income for the parent corporation. See 26 U.S.C. § 338 (West 1992); American States, 352 Ill.App.3d at 351–52.

5.  We note for the record that, effective July 30, 2004, the Illinois General Assembly radically amended, prospectively, the definition of “business income” which applied to the instant cause. As a result, the functional test, which also applied herein, no longer exists. Essentially, then, the arguments raised in this appeal would have no relevance in a similar situation occurring today.

FITZGERALD SMITH, P.J., with O'MARA FROSSARD and TOOMIN, JJ., concurring.